Provident Funds

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PROVIDENT FUNDS

Contribution rates to provident fund, pension and other social security systems (Employees Social Insurance Scheme and Employees Deposit Linked Insurance Scheme) are already quite high. The Committee is of the opinion that there is no need to step them up further.

Premature withdrawals should only be permitted in the event of permanent disability, death, or for specific purposes relevant for old age income security (e.g. housing). Individuals who opt for self-employment or take up employment at an establishment where provident fund provisions are absent, should be discouraged from withdrawing their accumulations before age 60. They may transfer their accumulations to an Individual Retirement Account.

Premature withdrawals (before age 60) should attract a flat, 10% withdrawal tax, deductible at source. This disincentive will also encourage members to consider alternative fund sources (banks, housing finance companies and medical insurance) to supplement their savings for other needs. Provident fund withdrawals should also be taxed at the rate of 10% after retirement over and above an initial exemption of Rs.1,00,000.

The portion of accumulations at maturity that are used for purchasing an annuity (from annuity providers registered with the IRA) or for other investments specified in Section 54E, should however be exempted from the 10% withdrawal tax. The annual income from annuities should however be taxed at prevailing rates.

Delayed receipt of provident funds should be permitted. While a member may stop contributing to the provident fund from age 60, he should be allowed to accumulate till the age of 65 - thereby enabling the member's accumulations at age 60 to further benefit from compounded returns - resulting in a larger annuity at age 65, should he decide to opt for it.

Improvement in Rate of Return

The present concept of limited, assured returns should be abolished. Instead, returns should be determined from year to year depending upon annual earnings. This will remove the upper limit for returns over a multiple decade investment horizon to members and also eliminate the need for any potential government subsidy.

To encourage maximisation of returns on investments during accumulation, the present tax on earnings over 12% should be abolished.

Fresh provident fund accretions, as well as earnings from investment of existing funds should be managed by professional, competing fund managers registered with the Securities and Exchange Board of India (SEBI).

All exempted establishments should be mandated to engage a professional fund manager registered with SEBI, to manage their existing and incremental provident fund accumulations for superior returns and better risk management, and more effective governance.

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